Economy 1996 Face-Off

Contributing editor Jack Stack is president and CEO of SRC Holdings Corp., based in Springfield, Missouri. The company's innovative style of open-book management -- financial information is shared among managers and employees -- is summarized in Stack's book The Great Game of Business, coauthored with Inc. editor at large Bo Burlingham.

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NORM BRODSKY Nowhere to Go but Down 'things couldn't be rosier, people keep saying. But if things can't get rosier, then what?' Jack, you're a good businessman, but you've been listening to too many bankers, economic forecasters, and government officials. Tell me, when was the last time those people were right?

Look, I'm not a doomsday guy, far from it. I'm generally an optimist. But I am nervous about this economy. And I get especially nervous when I hear people say, "Inflation's down. Interest rates are down. The economy's growing. Things couldn't be rosier." You know what? They're right. Things couldn't be rosier. And if things can't get any rosier, then what?

Not that we're heading into a depression, but I do think we're in for a period of sluggishness and deflation that will last for years. I expect the turn to come in the next 6 to 10 months. No later than the end of 1996. It will probably start with a big drop in the stock market and snowball from there.

I don't think we are prepared for this. Most of us have never lived through a really bad market, in which values go down. And down. And down. And they never come back. People generally think, "If there's a crash, the market will eventually recover. Look at 1987." But what if the market doesn't recover? What will happen to the $3.4 trillion in mutual funds? How are people going to respond as they see their savings, their retirement money, their entire net worth shrinking year after year after year?

The fact is that the consumer drives the economy, and right now the consumer is seriously overextended. We're in the midst of a downsizing trend that isn't going to stop anytime soon. Part of it has to do with overseas competition, but the root cause is technological innovation, which is accelerating. I've heard estimates that a billion-dollar company will need just 1,000 employees 10 years from now, versus about 7,000 today. What's going to happen to the other 6,000 people?

One thing I know for sure: discretionary income is going to fall. It's already fallen a lot. The problem is, spending hasn't fallen nearly as much. People have made up the difference by going into debt, a lot of it on credit cards. They can't keep it up. Eventually, they'll stop buying, and we know what effect that will have on business. I mean, what happens when you're stuck with inventory you can't sell? You cut prices, right? I think we're going to see a lot of price-cutting in the coming years. It's already begun. People think the cuts are temporary, a passing phase. They're wrong. This will become a way of life. So while everyone is guarding against inflation, the real danger is coming from the opposite direction: deflation.

What might offset that trend? Not the government. We're looking at long-term massive cuts in government spending, which means more layoffs. And the private sector won't pick up the slack, either, at least not in the short term. Companies are very cautious. Even with interest rates low, they aren't borrowing, and the banks are getting desperate. They're going after loans they wouldn't have touched a few years ago -- which means they're taking on additional risk. It also means some companies are taking on debt they won't be able to repay.

Meanwhile, the stock market is haywire. It reminds me of August 1987. I see the same mentality. I hear people talking about all the money they've made in mutual funds and stocks, and these are not knowledgeable investors. I see deals being done in my own industry that make no sense from an operating standpoint. Then I see the stock of those companies trading at multiples that are out of whack. It just can't last.

Of course, the trick is to be ready when the bubble bursts. Take my storage business. I'm not the low-cost provider, but I could be. Right now I sell on quality and service. Maybe I should prepare to sell on price. I want to position myself so that if I'm right, I can take advantage of what happens.

You may be in a different situation, Jack, but I have to say this seems like the wrong time to be adding capacity. And, yes, I do think people should be careful with their cash. They should think twice about going into new markets. They should resist the temptation to take on additional debt. I'm not saying pull in your horns. Companies can still expand, but you should expand into something that takes advantage of the change.

I don't mean to sound glib about all this. I take no pleasure in seeing people suffer. But good things can come out of bad times, as you know. Any change makes for opportunity. You lack opportunity only when things are stagnant. There are going to be a lot of opportunities in the coming years, no matter which of us is right. The important thing, I suppose, is to follow what you believe. In business, the worst thing you can do is to sit on the fence.

I wish I could believe your scenario, Jack. Listening to you, I have half a mind to move to Springfield. On second thought, however, I think I'll wait a couple of years. By then, you should have plenty of empty warehouse space you'll be able to rent to me real cheap.

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JACK STACK Looks Like Up to Me 'We're in an economic boom that could last another five years. The driving force is capital.' I've always admired your street smarts, Norm, but I have to wonder which streets you've been hanging out on lately. Here in the Midwest, the future looks nothing like what you're describing. In fact, it looks so good it's almost scary.

And believe me, we are a very cautious company. Every fall, we hold a two-day off-site meeting at which our salespeople and general managers give us detailed sales forecasts for the coming year. These are intense sessions. We're all aware that the results are going to have a direct effect on the job security of everyone who works for the company, and that everyone is going to see that effect.

This year we held the meeting at the end of October, and the verdict was unanimous: the economy is strong and growing. This isn't just our opinion. It's what we're hearing from our customers, ranging from small automotive shops to national truck retailers, from agricultural-equipment dealers to giant manufacturers -- more than 100 different companies in all, operating throughout the country. We ourselves are forecasting that all but one of our businesses will grow in 1996, at rates ranging from 5% to 10%.

I don't think this is an election-year aberration. I think we're in the midst of an economic boom that could last another five years. The driving force, I believe, is capital. There's a lot of capital floating around and more coming in. Foreign manufacturers are investing here. Exports are rising. People are saving more, putting a ton of money into 401(k)s and other retirement accounts. Where is it going to go?

There's really just one place it can go when interest rates are low: the capital markets. You put it there, and you're putting it back into business. You're creating start-up capital for new businesses. You're creating expansion capital for growing businesses. Money is going to be plentiful and cheap for a long time to come. Businesses are going to invest, and the economy is going to grow.

Understand, I'm not saying every sector is going to grow. There are always weak sectors in a strong economy, just as there are strong sectors in a weak economy. To see the overall trend, you have to look at the foundations. The foundations of this economy are rock solid.

Take manufacturing. You say, Norm, that most of us have never lived through a really bad market. You're dead wrong when it comes to the Rustbelt. We lived through 15 years of tough times, of continual layoffs and downsizing, of being told we were dinosaurs who could never compete in the new global economy. All that time, we were learning and changing. Now comes the payoff.

Frankly, I've never seen the manufacturing sector as strong as it is today. Listen to companies like General Electric. Listen to the National Association of Manufacturers. They're saying, "Look, we've got our processes in line. We've got our overhead in line. We've got our quality in line. We can take on anybody in the world." That's big talk. It's talk we haven't heard before. They're saying, "We've made the necessary improvements, and they should be taken into account in forecasting growth."

There are just so many positive factors out there. I don't agree that banks are desperate. I sit on the board of a bank. Its default rate on commercial loans is less than 0.1%. The truth is, our banks are healthier now than they've ever been. Our technology is the envy of the world. Our ability to create jobs is unequaled.

Are consumers overextended? Perhaps in some areas. But that could change fast if interest rates keep dropping. Give everyone another $100 a month to spend, and you're going to generate a lot of economic activity. And I think cuts in government spending will help the economy, not hurt it. They've already helped. We have substantially slowed down the rise in health-care costs. Additional cuts are simply going to increase the supply of money and make it cheaper for everybody.

It's already so cheap that you're almost forced to find productive uses for it. We recently had our bank do what is called a debt-capacity study. Our bank debt is currently about $8 million, and our debt-to-equity ratio is 1.2 to 1. The bank looked at our existing businesses and concluded we could safely borrow up to $15 million more. I hate debt, but how can we pass up good growth opportunities with money available and interest rates low? We don't intend to. We've already identified one company, a manufacturer of oil-field equipment, that we plan to acquire. We'll also add some capacity to our existing businesses. Our plan is to grow by about 15% overall in 1996, from $104 million to $119 million in sales, while increasing our debt by about 20%.

Yes, we have trapdoors and contingency plans to pro-tect us in case you're right, Norm. The chances of that are very slim, however. They're so slim, in fact, that I'm thinking of sending your article to our competitors in hopes that they'll follow your advice. Then we can just sit back and watch them disappear in the rearview mirror.

Norm Brodsky is a veteran entrepreneur whose six businesses in-clude a former Inc. 100 company, an Inc. 500 company, and a Brooklyn, N.Y., start-up he hopes will become eligible for the list in 1996. He is the author of the Inc. column Street Smarts, which will appear every other month.This column was coauthored by Bo Burlingham.

Jack Stack is president and CEO of Springfield Remanufacturing Corp., in Springfield, Mo., and the author, with Bo Burlingham, of The Great Game of Business (Currency/Doubleday, 1992).